In a report from Merrill Lynch, analysts recommended returning to neutral in lower coupon 15s relative to 30s.
In mid-December, they considered lower coupon 15s to be more attractive than lower coupon 30s as there was hardly any yield difference.
With a pick up in lower coupon origination in the past couple of weeks, along with clarification from the Federal Reserve that 15-year agency MBS would also be in their purchase mix, the yield difference between current coupon 30s and 15s has widened to around 45 basis points from four basis points. Analysts add that in terms of price, 30-year 4.5s declined 23+ over the period between Dec. 18 and Jan. 2, while Dwarf 4.5s and 4s gained 10+ and 15, respectively.
Merrill suggested some part of the price movement could be related to prepayment expectations with the market pricing slower speeds on 15s relative to 30s. There is historical precedence for this as back in 2003 30s were faster than 15s as a result of their larger loan size and a longer horizon over which to gain from a lower rate, said analysts.
On the other hand, they point out that 15s have had less impact by the decline in home prices and tighter credit due to their lower initial LTVs, faster amortization and better credit borrowers. Analysts also add that with the current coupon difference back near 50 basis points, Dwarf 5.5s are more nearly equivalent in terms of basis points in the money as 30-year 6s.
The above highlights the uncertainty of whether 30s or 15s will prepay faster. Merrill said that 30s could get off to a faster start as the 15-year rate lagged the 30-year rate. But if the best borrowers exit 30-year pools and the agencies do not pursue streamlined refinancing, then greater burnout could be seen on the 30-year side, analysts said.
This is one trend that needs to be observed going forward, analysts said, for determining fair value between 15s and 30s.
